Tax planning strategy #3: Tax efficient profit extraction

As a business owner and director, understanding how best to pay yourself and extract profit from your business tax efficiently is crucial to your personal tax and wealth planning.

Salary vs dividends 2025

For many years, the advice on tax-efficient profit extraction was straightforward and often resulted in owner managers being paid a nominal salary topped up with profit sharing dividends. However, this has now changed as the tax saving between using salary or dividends has narrowed.

With changes in Corporation Tax rates, National Insurance, tax-free dividend allowance and dividend tax rates, the advice for each business owner on tax-efficient profit extraction can now be very different.

When considering the most tax-efficient way to extract profit from your business, you must consider both personal and corporate tax planning.

In the past, the main advantage of dividend payments was that they were exempt from all types of National Insurance Contributions (both for the company and the shareholders) and were effectively taxed at substantially lower rates than salary. However, dividends are paid out of post-tax profits and as such are not eligible for corporation tax relief.

Furthermore, your decision on extracting profits shouldn’t be wholly focused on tax efficiency but should also consider your business and personal goals.

In this article, we look at a variety of areas to consider when extracting profits from your business.

Tax efficiency

Here are some examples which show the complexity of deciding how to extract profits in the most tax-efficient way in 2025/26. These calculations consider corporation tax, tax-free dividend allowance, dividend tax, and employer-related national insurance.

Example 1: For a basic rate taxpayer running a company that pays the lowest rate of Corporation Tax at 19%, for £1k of profit, paying yourself a dividend would net you £739.13 of the £1k profit. If you paid that in a salary, you’d only net £626.09 of the £1k.

Therefore, for someone in this situation, dividends can still be a very tax-efficient way of paying yourself.

However, for higher rate and additional rate taxpayers, the tax saving has narrowed and indeed, salary may be better if you take into account that larger companies pay higher rates of Corporation Tax, for example, the higher rate of Corporation Tax of 25%, or the 26.5% marginal rate of Corporation Tax.

Example 2: For a higher-rate taxpayer running a company that pays 25% Corporation Tax, for every £1k of profit, paying yourself a salary would net you £504.35, whereas paying yourself a dividend would net you £496.88.

Example 3: For an additional rate taxpayer, running a company that pays 25% Corporation Tax for every £1k of profit, paying yourself via a salary would net you £460.87, and paying yourself a dividend would net you £454.88.

Other considerations

How you extract profits should not only be driven by tax efficiency.

For example,  if you are claiming R&D tax credits and you are involved in your company’s R&D work, you may want to pay a salary. This can then be included as part of the costs on your R&D tax relief claim and may result in a better overall tax outcome.

Other tax-efficient ways of extracting profit from your business

Pension contributions

Pension contributions have always been a tax-efficient way of taking profit out of your company. For the business, the contributions are an allowable business expense and  thereby save corporation tax.

Unlike personal pension contributions, which are paid out of income which has already been subject to tax, employers and employees national insurance, company pension contributions are paid free of such deductions. As a limited company director, your business can contribute up to £60,000 per year to your pension as well as allowing a top up of any unused allowances for the preceding 3 years if you were a member of a qualifying pension scheme.

The Government also recently increased the point at which an individual’s annual allowance will be tapered. This is now £260,000. The allowance will continue to be reduced by £1 for every £2 of an individual’s ‘adjusted income’ that is over £260,000. This will start to affect your allowance once your income from all sources is over £200,000.

The minimum tapered allowance has increased to £10,000, up from £4,000 in previous years. This means individuals earning over £360,000 can still contribute up to £10,000 to their pension arrangements.

Remember that your pension can only be accessed from age 55 onwards and you can take up to 25% tax-free. However, despite the limitations of the age at which you can access your pension and the amount of tax-free cash you can access from a pension, the abolition of the Lifetime Allowance in 2024, allows business owners to increase the total amount they can accumulate in their pension funds.

Pensions have always been used in IHT planning as they do not currently form part of a person’s estate for Inheritance Tax purposes. However, it was announced in the 2024 Autumn Budget that from 6 April 2027, unused pension funds and death benefits payable from a pension will form part of a person’s estate for IHT purposes. This change is still undergoing consultation. There may be more news about this in the March 2025 Spring Statement or the 2025 Autumn Budget.

Interest on directors’ loans

If you’ve loaned money to your company, you can be paid interest on the amount you’ve loaned, provided the interest rate is commercially justified.

This is an allowable expense for the company and will save corporation tax. Interest received by individuals is also free from Employers and Employees National Insurance whilst the actual income remains taxed at the same level as salary income. This makes interest payments a more tax efficient way of remunerating owner directors than both salary or dividend.

Charges for personal assets used by the company

If you personally own assets that are used by the company (e.g. a freehold property) then you can charge the company a commercial rent for using that asset. Again such charges secure a deduction for corporate purposes and are exempt Employers and Employees National Insurance putting them in the same tax efficiency bracket as interest payments.

Conclusion

In the past, assessing the tax efficiency of how to extract profits has been much more straight forward than it is today. With the changes to Corporation Tax rates, NI, tax -free dividend allowance and dividend tax rates over recent years and particularly in the 2024 Budget, the assessment is no longer simple and we would advise business owners to revisit how they extract profits from their businesses with their tax advisor.

The Spring Statement, due on 26^th March may change some of the above points and we will keep you informed of all the announcements made and their impact.

For more help and advice on tax-efficient profit extraction, contact us today.